LOG Commercial Properties e Participações (BVMF:LOGG3) Has A Pretty Healthy Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that LOG Commercial Properties e Participações S.A. (BVMF:LOGG3) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for LOG Commercial Properties e Participações

How Much Debt Does LOG Commercial Properties e Participações Carry?

As you can see below, LOG Commercial Properties e Participações had R$800.7m of debt at December 2020, down from R$889.8m a year prior. However, because it has a cash reserve of R$453.9m, its net debt is less, at about R$346.8m.

How Healthy Is LOG Commercial Properties e Participações' Balance Sheet?

We can see from the most recent balance sheet that LOG Commercial Properties e Participações had liabilities of R$330.5m falling due within a year, and liabilities of R$801.7m due beyond that. On the other hand, it had cash of R$453.9m and R$38.8m worth of receivables due within a year. So its liabilities total R$639.6m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because LOG Commercial Properties e Participações is worth R$3.10b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

LOG Commercial Properties e Participações has a debt to EBITDA ratio of 3.5 and its EBIT covered its interest expense 6.2 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. We note that LOG Commercial Properties e Participações grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine LOG Commercial Properties e Participações's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, LOG Commercial Properties e Participações actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Happily, LOG Commercial Properties e Participações's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its net debt to EBITDA. When we consider the range of factors above, it looks like LOG Commercial Properties e Participações is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for LOG Commercial Properties e Participações you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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